From time to time I find myself in a foreign country driving on what we would consider the "wrong" side of the road, sitting on the "wrong" side of the car and trying to shift gears with the "wrong" hand. I can handle it, but down deep I am uneasy because I know that in a crisis, all of my instincts would be wrong.
Chinese President Xi Jinping has the same problem facing his first real fiscal crisis. A roaring stock market was perfectly acceptable to Xi's government which actively encouraged ordinary citizens to invest. But the free market giveth and the free market taketh away. The Shanghai Composite stock index has fallen by a third, wiping out the savings of millions of Chinese. By some estimates, about $4 trillion disappeared, and it's still falling.
It is almost comical watching a communist regime try to manage a financial crisis. "When a market malfunctions, the government should not let market sentiment turn from bad to worse," opined People's Daily, the official newspaper of the communist party. "It should use powerful measures to strengthen market confidence." Thus, Beijing suspended trading in almost half of the companies traded on major indexes and ordered the huge government pension fund to buy stocks. But just as predictably its efforts have failed to restore confidence.
What People's Daily failed to grasp is that the Chinese stock markets have not malfunctioned at all. They are in fact going through a normal free market correction to a bubble created when a torrent of new investors push stock prices far above their real value. It is painful and disruptive, but that is the way the free market works.
The Chinese government should have reacted with further efforts to relax government control of the economy, curbing the influence of state-owned enterprises and letting the free market do its thing. Instead, it reacted like the communist regime of old. It made billions available to the China Securities Finance Corporation to prop up the stock markets. It ordered the media to pare back on coverage of financial markets, and has vowed action against traders who engage in "malicious short selling."
The manipulation of the markets by the government, even more than the market retreat itself, spooked foreign investors. The hedge fund Bridgewater Associates LP was once bullish on China. "Our views about China have changed," said Bridgewater's billionaire founder Raymond Dalio. "There are now no safe places to invest." Kingdon Capital Management LLC, a nearly $3 billion hedge fund, told clients it had sold all of its shares in Chinese companies listed on the Hong Kong stock exchange. Blackrock warned that if the government continues to bolster markets, "there will be fewer global participants" in China's exchanges.
The exodus of foreign investors will undermine China's efforts to foster high-tech zones to stimulate innovation. Xi realizes that to grow and prosper, China must get ahead of the technology curve, but that depends on creative entrepreneurs pursuing their ideas. The heavy hand of bureaucracy is antithetical to the free market. Xi wants to stem the slide in the stock markets, but in this crisis his instincts are all wrong.
Jerry Jasinowski, an economist and author, served as President of the National Association of Manufacturers for 14 years and later The Manufacturing Institute. Jerry is available for speaking engagements. July 2015